Chart of the week: Are Barclays shares about to rocket?

by John Burford from interactive investor |

Selling pressure is drying up and a selling climax could set the stage for a huge rally phase.

Is Barclays set up for a solid recovery now?

Long-time readers will know that I have been steadfastly bearish on UK bank shares for a very long time with Lloyds Banking Group (LSE:LLOY) and Barclays (LSE:BARC) to the bearish fore.  My stance has paid dividends (but not literally!) as short positions have been well rewarded.  But is it time to re-assess and even consider taking a bullish stance?

One of the major constraints on the banks has been the minuscule spread margins they have been allowed to make on loans, mortgages, and so on.  The mainstream media is full to brimming of the dire effects of the margin squeeze highlighted by the infamous 'yield inversions' in US Treasuries.  Bearish sentiment towards 'lower for longer' interest rates is running at fever pitch.

The conventional 'wisdom' of the pundits has it that because major economies are slowing, interest rates can only go lower as central banks are being forced into applying more 'stimulus'.  But what if they are wrong and that market forces are already on the turn?  I have shown before that the US Federal Reserve, for instance, only reacts to rate changes as dictated by the market – it never leads.  And most other central banks take their cues from the Fed. This fact is lost on most economists and analysts.

Here is the long-term weekly chart for Barclays showing the wonderful Barclays Wedge:

Source: interactive investor  Past performance is not a guide to future performance

How the mighty have fallen! At the end of August, the shares made a two-year low at 135p, which is not far off a new 10-year low.  Ouch!  But there are two important features here – first, the large momentum divergence in force for three years and second, the potential ‘overshoot’ of the lower Wedge line.

The momentum divergence is a clue that selling pressure is drying up and the overshoot – if it comes off – an indication that last week saw a selling climax that sets the stage for a huge rally phase.  Here is a close-up of recent action:

Source: interactive investor  Past performance is not a guide to future performance

From the latest hit on the upper Wedge line, the market has descended in five Elliott waves (that may or may not be complete).  Remember, fifth waves are ending waves prior to a reversal.

This sets the scene for a reversal of fortune – just as bullish sentiment is on the floor (after months of a big bear phase).  We are seeing a plethora of media articles explaining why the shares 'fell 11% in August' to add to the gloom, and why the PPI pay-outs could be much greater that thought.  In addition, both Lloyds Banking Group and Barclays are now being downgraded by analysts – a comforting thought for we merry band of contrarians!

For those reasons, I have been covering short positions for major profits.  I am also taking small long positions here using the recent low as my fail-safe.  If that low holds and the shares can climb back above the 170p area inside the Wedge, the 'overshoot' would be genuine – and herald a swift rally up to the 170p area with higher potential.

Finally, the European Central Bank (ECB) meets on Thursday this week, and most expect it to lower its policy rate below the minus 0.4% currently prevailing in order to juice the flagging eurozone economy.  But what if they make no changes, or just a small adjustment?  Eurozone bond yields should go nuts (to the upside) – and EU and UK banks rocket.

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John Burford is the author of the definitive text on his trading method, Tramline Trading. He is also a freelance contributor and not a direct employee of interactive investor.

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